European monetary union

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INTRODUCTION

During the last 30 years or even longer period of time the European Union represents the phenomenon which has never been known in the history of the International Law. It's nature, system rules, the ways of it's development are at issue in the scientific circles all over the world. Lots of questions are arisen in front of the researchers of the European Union. And first and foremost is "what is the legal nature of the European Union nowadays? If it is "classical" international organization or confederation or may be it is a new structure that has no analogues in the past?"

There are actually three points of view on this matter.

The fist states, that even now the European Union is an international organization, though it has a lot of very specific characters.

The second considers the European Union as a kind of confederation - a protoplast of the future federation that sooner or later will take place on the European continent.

The third claims that the European Union is totally new subject that can be classified neither as international organization nor as a state body but at the same time it has traces of both structures.

One of the main distinctions of the European Union from any other international organization is it's monetary system and the system of banks that consists of the European Central Bank and the National Central Banks of member-states.

1. THE EUROPEAN MONETARY UNION

(Basic description)

monetary banking target payment

We can count three stages of the European Monetary Union development.

On the first stage European currency system entered into force on 13 March 1979 and the European currency unit (ECU) appeared. During this stage there was no single body vested with strict financial powers but close cooperation of the National Central Banks of member states that was quite typical for the international organization.

On the second stage (January 1994 - December 1998) a new structure has been created. The main task of European Currency Institute was actually a preparation to the third stage and creation of the European Central Bank.

European Monetary Union as we know it now started on January the 1-st of 1999. That is the third stage of the aforecited process.

According to the articles of the Maastricht Treaty, to become the part of the EUROzone a member state should be in congruence with a number of demands, so-called "convergence criteria". So member country can join the European Monetary Union if:

1. its inflation rate is not more than 1.5 % higher than the average of the three lowest inflation rates among the European Union member states;

2. its long-term interest rate is not more than 2 % higher than the average observed in these three low-inflation countries;

3. it has joined the exchange rate mechanism of the European Monetary System and has not experienced a devaluation during the two years preceding the entrance into the union;

4. its government budget deficit is not higher than 3% of its GDP (if it is, it should be declining continuously and substantially and come close to the 3% norm, or alternatively, the deviation from the reference value (3%) should be exceptional and temporary and remain close to the reference value, Art. 104c (a));

5. its government debt should not exceed 60% of GDP (if it does it should diminish sufficiently and approach the reference velue (60%) at a satisfactory pace Art. 104c (b))

By the 1998 eleven member states of the European Union satisfied convergence criteria. These were Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. Greece joined this club on 1 January 2001. And from the very beginning of the 2002 EURO was introduced in the territories of 12 member states as in its physical form. We can see conversion rates in the beginning of the process (1999) in the table below.

Slovenia was the first of the countries from the 2004 enlargement to join the euro area on 1 January 2007, then in 2008 Cyprus and Malta followed its example. Thus now the EUROzone consists of 15 members.

It is interesting to know, that there is a consensus among many economists that EU-27 (the quantity of the European Union member states as a whole) and even EU-15 does not form an optimum currency area. The main reason and the result of economic analysis here is that the economic costs of such a union seem to be larger than the profits for every of a significant number of countries. The minimum number of the European Union members for which a monetary union is optimal is generally believed to include Germany, the Benelux countries (Belgium, the Netherlands, Luxembourg) and France.

At the same time the economical cost-benefit calculus produces quite different results for the different European Union countries. For the European Union members that have a large degree of openness to their partners such cost-benefit calculus is likely to show advantages of being in the European Monetary Union. Here we can call Belgium, Luxemburg, Ireland and some new European Union members - Czech Republic, Slovakia, Estonia, Hungary and Slovenia. A very striking moment here is that the new member-states (mostly the Central European countries) which joined the European Union in 2004 were quite ready to be integrated with the rest of the united Europe. As for some "elder" countries - the United Kingdom or Greece, for example, it is less clear that they belong to an optimal currency area with the rest of the European Union.

Anyway it is very difficult to do a precise and clear conclusion about how many of 27 countries are optimal for effectively working currency area so there is no consensus about how large should be such a monetary union where every country can get real profit from being there.

2. THE TARGET PAYMENT SYSTEM

Before we turn to the detailed study of the Eurosystem, that includes the European Central Bank and the National Central Banks of the member states a few words should be said about the TARGET payment system.

TARGET (Trans-European Automated Real-time Gross settlement Express Transfer System) is the large-value euro payment system operated by the European System of Central Banks. This is a decentralised system based on the interlinking of the payment systems of each country. The main characteristic of TARGET is that it is a real-time gross settlement system, so that the payment orders entered are settled individually (without prior netting) and the payment itself reaches its destination "instantaneously", i.e. with a delay of a few seconds or minutes. For this purpose, the sending institution must either hold a balance in its account with the relevant central bank, or else be granted the necessary credit by the latter.

The main three objectives of TARGET system are:

· to provide a safe and reliable mechanism for the settlement of EURO payments on a real-time gross settlement basis;

· to increase the efficiency of cross-border payments within the EUROzone;

· to offer a fast and secure vehicle for implementation of the single monetary policy within the European Union countries.

Accordingly, all the monetary policy operations carried out by the central banks of the countries participating in Economic and Monetary Union are channelled through TARGET. This system can also be used for any other payment denominated in euro, whether it be a money market or a commercial transaction. It is important to add that, in principle, all the central banks of the European Union members, and not just those belonging to the EUROzone, can be connected to the TARGET system for the settlement of euro-denominated transactions.

3. EUROSYSTEM: THE EUROPEAN CENTRAL BANK AND THE NATIONAL CENTRAL BANKS OF MEMBER STATES

The European Central Bank from some point of view also represents very interesting phenomenon among other international financial institutions. The history of the international organizations development knows a lot of different financial structures. We can name such institutions as International Monetary Fund, European Bank for Reconstruction and Development (EBRD), etc… But it has never been in the practice of these or any other international organization, that their decisions had a direct effect to the state bodies and even citizens of member countries. Nevertheless exactly this very situation we discover when we study the European Central Bank and other decision-making bodies of the European Union. The point here is that their rulings are obligatory for the citizens and bodies of the European Union member states and have no need to be ratified by them.

Another interesting feature that has already been spoken about here is a cash turnover in the European Union that is not typical for international organizations even nowadays. And the European Central Bank is certainly the main ruler and regulator of this process. So let us closely look through the history of creation, structure and goals of this bank and the system of National Central Banks it takes charges of.

In the beginning of the second half of the XX century two models of central banking have evolved. These are so-called Anglo-French model and German model that differed from each other on two counts:

· The main goals of the central bank.

In the Anglo-French model, the central bank has several primary objectives such as financial stability, high employment, price stability, etc. The price stability here is only one of the tasks and doesn't takes privileged position among others.

It is all very different in the German model, where price stability is surely the primary objective of the central bank although other objectives are also taken into account.

· The place of the central bank in the system of the decision-making bodies.

In the Anglo-French model the central bank is quite dependant body and its main policy decisions are in need of government's approval.

The German model on the contrary is characterized by the principle of political independence of the central bank. Thus for example decisions about interest rate are taken by the central bank without interference of the political authorities.

Such position is taken first and foremost because it is considered that political independence of the central bank leads to less inflation.

When the Maastricht Treaty was elaborated in the beginning of 90-th one of these above spoken models had to be chosen and after all the German model prevailed.

There are two reasons why this happened.

The first reason has deep roots that one can call the "monetarist counter-revolution". That means ideas and conceptions that became popular in the 1970s and are still in force in the western countries. In a monetaristic view, public authorities can not constantly lower the unemployment rate below its natural level. They can only do it temporarily. So the natural unemployment rate can be lowered only through appliance of so-called "structural policies" which means introducing more flexibility in the labor market and lowering labor taxes. Hereby, the central bank must occupy itself only with what it can control, particularly the price level. Besides, in accordance with monetarists conceptions the central bank should be protected from political pressures so it have to be independent.

The second reason is strategic position of Germany during evolving of the European monetary union. The German authorities faced the risk of having to accept higher inflation when they entered monetary union. So, in order to accept it, they insisted on having the European Central Bank that gives even higher level of price stability than their own Bundesbank did.

So what we can now call the Eurosystem was established due to the articles of the Maastricht Treaty (there is also the Statute of the European System of Central Banks and of the European Central Bank) and consists of the European Central Bank, headquartered in Frankfurt, Germany, and 15 National Central Banks of participant countries. Besides, three countries that are not members the European Monetary Union (Denmark, Sweden and the United Kingdom) are allowed some input into the European System of Central Banks but do not participate in decisions about monetary policy for the "EUROzone".

In this table one can see the percent shares of the NCB's capital in the authorized capital of the European Central Bank:

The governing bodies of the Eurosystem are:

· The Executive Board

· The Governing Council

The Executive Board includes the President, the Vice-President and the four directors of the European Central Bank. Its main responsibilities are to prepare Governing Council meetings, implementation of monetary policy for the EUROzone in accordance with the guidelines specified and decisions taken by the Governing Council, giving the necessary instructions to the EUROzone NCBs, managing the day-to-day business of the European Central Bank.

The Governing Council is the main decision-making body of the Eurosystem. It consists of the six members of the Executive Board and the governors of the 15 National Central Banks of the EUROzone countries. The Governing Council formulates monetary policies and takes decisions concerning interest rates, reserve requirements and provision of liquidity into the system. The meetings of this body take place twice a month at the Eurotower in Frankfurt, Germany.

At its first meeting each month, the Governing Council assesses monetary and economic developments and takes its monthly monetary policy decision. At its second meeting, the Council discusses mainly issues related to other tasks and responsibilities of the European Central Bank and the Eurosystem.

Each of the members of the Governing Council has one vote. This is unlike the European Council of Ministers for example, but it is considered that the Governing Council should be concerned with the interests of the European Union as a whole and not with the interests of particular member states.

There is also such a body as General Council that comprises of the President and Vice-President of the European Central Bank, plus the governors of the National Central Banks of the 27 European Union member states.

The General Council can be regarded a transitional body. It carries out the tasks taken over from the European Monetary Institute which the European Central Bank is required because of the fact that not all European Union members have adopted the euro yet.

In accordance with the Statute of the European System of Central Banks and of the European Central Bank, the General Council will be dissolved once all the European Union member states have introduced the single currency.

To follow the monetary policy in the European Union and particulary - in the EUROzone (15 EU member countries), European Central Bank has to formulate its priorities in its future actions. This includes the definition of ultimate targets (inflation, output) and intermediate targets. The intermediate targets are actually set to influence the ultimate ones that give to the European Central Bank the opportunity to react on some particular situation more directly and operatively.

The first step in the formulation of the monetary policy strategy is to give a precise definition of price stability. Thus the Governing Council of the European Central Bank has adopted the following definition: "price stability shall be defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2 %"(ECB Monthly Bulletin, 1999). Later on, in 2003 the European Central Bank specified this definition of price stability by stating that an inflation objective should be below but close to 2 %, which means that the inflation within the limits of 2 % is a level "to be maintained over the medium run".

There are two ways for the European Central Bank to achieve this strategy.

The European Central Bank makes the forecasts for the future trend growth of the real GDP and the future velocity of money. With these two numbers fixed the European Central Bank finds the growth rate of money stock that is consistent with the inflation target that is at most 2 %. Through the system of calculations using these two parameters the European Central Bank draws conclusions that the money stock should not be increasing by more than 4,5 % per year. This is then the target for the money stock growth.

The second way of the monetary policy strategy is to identify a number of variables that provide important information to forecast the future inflation process. "These variables include inter alia wages, the exchange rate, bond prices and the yield curve, various measures of real activity, fiscal policy indicators, price and cost indices and business and consumer surveys" (ECB Monthly Bulletin, 1999). Thus if, for example, wages increase markedly in Euroland, the European Central Bank may consider this as a threat to the future price stability and may therefore take appropriate action (in this case increase the short-term interest rate and\or reduce liquidity in the system).

At the same time, it is very important to add that to avoid the problem of credibility of the European Central Bank, it decided in 2003 to amend its "two-pillar" strategy and to reduce the importance it gives to the money stock in its monetary policies. So now the money stock (the first of above described ways) is given the same importance as the variables listed in the second way.

Thus de facto, the European Central Bank now uses a "one-pillar" strategy of the inflationary tendencies management in the EUROzone using a wide range of variables including the money stock.

Thereby as a resume of this chapter we can mark four main tasks the Eurosystem has to perform.

The first task is to carry out the monetary policy adopted by the Governing Council of the European Central Bank. The Executive Board at the same time is responsible for implementing the monetary policy, a responsibility it exercises by giving instructions to the National Central Banks.

The second and third tasks of the Eurosystem are to conduct foreign exchange operations and to hold and manage the official reserves of the euro area countries.

The National Central Banks of the member states are involved in the management of the ECB's foreign reserves. They act as agents for the European Central Bank, in accordance with guidelines set by it. The remaining Eurosystem foreign reserve assets are owned and managed by the National Central Banks. Transactions in those reserve assets are regulated by the Eurosystem. Some transactions that are above certain thresholds require prior approval from the European Central Bank.

A fourth main task of the Eurosystem is to promote the smooth operation of payment systems (such as TARGET). Furthermore, the Eurosystem is the main actor in the matters that are concerned of financial supervision: it advises legislators in its field of competence and it compiles monetary and financial statistics.

The European Central Bank also has the exclusive right to authorize the issue of euro banknotes.

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